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Diving for Dollars

October 01, 1998 - Article

Posted: 10/1998

Diving for Dollars
Agents and their underlying carriers are increasingly diving into equity programs, bonuses and creative buy-backs. Will the golden parachutes open? Participants and observers share their views.

By Bob Titsch Jr. and Peter Meade

Agent equity programs have arrived. Their growth potential is astounding and the programs themselves may become equally compelling in the next several months.

According to estimates by Boston-based strategy consulting firm ATLANTIC-ACM, independent agents will account for about $8 billion, or 23 percent, of the $35 billion in U.S. interexchange services revenue generated outside of the Big Three retail machines. That's a lot of groceries in a market populated by long distance carriers and resellers shopping for customer bases. Clearly, many officers of companies billing less than $100 million in annual sales are trying to grow traffic volumes to levels that will attract a buyer.

One way of growing sales quickly is to contract with several master agents. The larger ones close deals with utility companies for 96 T1s and sell multimillion-dollar programs to Fortune 500 companies. Moreover, they have tens to hundreds of sub-agents working under their "umbrella," which makes them capable of growing a small long distance company's monthly revenue quickly.

But it's difficult to lure master agents away from the competitive and lucrative programs they already sell. In most cases, their current contracts have several enticements, including the flexibility to renegotiate rates as market conditions change, or else move their customer base to another service provider.

Enter the ultimate deal sweetener: equity.

Actually, agent equity programs of one form or another have been around since 1994 when UniDial Communications Inc., Louisville, Ky., burst onto the scene by selling $25,000 franchises that included a bonus payment at the time of a selling event. It wasn't long before other companies were offering bonuses and customer-base buybacks, sans the fee. But they were very quiet about it, sometimes playing the bonus card to selectively recruit top producers.

Today, at least eight Third Tier ($15 million to $100 million in sales) and Fourth Tier ($5 million to $15 million in sales) long distance companies are publicly offering some kind of equity program, and industry veterans predict that more are on the way.

"Any agent with a monthly revenue stream of $100,000 and a pulse is aware of equity programs," says Rick Deller, president of Intelisys Inc., a Petaluma, Calif.-based master agency.

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Image: Sample Payoff Schedule

These programs reflect a natural evolution in the relationship between carriers, resellers and agents, according to Steve Samuels, president of Telcorp. Ltd., a Hewlett, N.Y.-based switchless reseller that offers its agents an equity program. "For once, agents are in the right place at the right time," Samuels says. "With an equity program, they can turn their customer base into a sizable financial windfall without any of the risks typically associated with ownership."

Even so, major questions remain, such as whether the golden parachute will actually open. Many of the nation's largest agents own UniDial franchises. As successful as they are, they haven't cashed in on the back-end payout because UniDial has not been acquired. In another example, last year, a few months after Midcom Communications Inc., Seattle, began offering an agent equity program, the company imploded.

"These deals aren't risk-free," notes Ted Schuman, president and chief executive officer of US Telebrokers, a Phoenix master agency that's committed to Santa Barbara-based TMC Communica-tion's equity program. "You have to have faith in the people you're dealing with. I've known Bernadette [Richardson, president of TMC] for five years, and John Marsch [the company's CEO] has done this [sold his company] before. He knows what he's doing."

Other questions loom: Could an equity program complicate or get in the way of an acquisition? Could it change a long distance company's worth, or valuation? More importantly, how will these programs affect the working relationships of agents and service providers, and the agent channel itself?

The answer is: Dramatically.

Equity Anatomies

Equity programs differ but they are based largely on a predetermined formula that assigns a value to the agent's customer base at the time of a selling event. In most cases, the sales multiple the service provider gets is applied to a scaled percentage of the agent's monthly revenue stream. That percentage--and payoff--grows as the agent's customer base grows (see sample, page 44). If the sales multiple is eight, for example, an agent with a monthly base of $150,000 might be eligible for a 30 percent equity stake, and receive $360,000 (8 x $150,000 x .30). With $450,000 in monthly sales, the agent could be eligible for a 50 percent equity stake, and make $1,800,000 (8 x $450,000 x .50).

Service providers are reticent to discuss the specifics of their programs, but agents affiliated with various programs report that some equity contracts go well beyond multiplying one's monthly base with a percentage of sales. A facilities-based carrier, for instance, might deduct an amount for the purchase of specific assets such as inventory, intellectual property and facilities. Some service providers--switchless and facilities-based--may deduct debt from the total purchase price, which changes the agent's multiple dramatically.

Some programs require that agents support their customers and assist with their migration to the new carrier's network for up to 24 months, at which time they are completely paid off.

"What that does is create a higher multiple value for everyone in-volved," says Gene Foster, president of Communications Management Services (CMS), a San Diego-based agency that collaborated with Telcorp to model its equity program. "Generally, the service provider that's being acquired is paid off and exits the deal completely. That can't happen with the agents, because they're the ones with the customer relationships. If the agents suddenly go away, the acquirer risks a high level of attrition."

For this reason, most equity programs guarantee that the agent's residuals remain in place, according to Paul Silicato, a principal of Pompano Beach, Fla.-based Global Systems Telecommunications, a master agency. "You don't want to buy out the agent and say, 'Here's your parachute, go away,'" he warns. "That could be disastrous. The issue that concerns me, however, is does the company ever get bought? And at what multiple?"

Indeed, it's not unthinkable that potential acquirers would find a reseller with a "noisy" equity program unattractive, especially if there's a chance that some of the agents won't be happy with the terms. "What happens if the agents think the multiple is too low?" asks Mark Haney, a principal of Haney and Kobs, a Fort Worth, Texas-based law firm. "Then the buyer is going to have to deal with some very unhappy agents."

That's a legitimate risk, according to Brian Sledz, president of Naperville, Ill.-based Connect America, which offers a couple of different equity programs. Having bought back customer bases from agents, acquired several small resellers and sold a customer base to a public company (Network Long Distance), Sledz is certainly qualified to value customer bases.

"I think a lot of misinformation is being plugged into the marketplace and it's giving agents unrealistic expectations," he says. "Some resellers are saying they're going to get 14 to 20 times their customer base, and pay agents 50 percent of that multiple. How do they come up with these multiples, draw them from a hat? I can prove them wrong 10 ways 'til Sunday that no switchless reseller is going to get that kind of multiple."

Valuation expert Casey Freymuth, president of Group IV Inc., a Phoenix-based consultancy and publisher of "The Telecom Service Provider: How Much Is It Worth?" says it's rare for a switchless reseller to sell for more than seven times monthly revenue. "Historically, facilities-based companies get higher multiples," remarks Freymuth. "But banks and investors are beginning to emphasize churn now. With or without facilities, if a company has a lot of customers dropping off, it won't get a high multiple. Dollar for dollar, the best place for service providers and agents with equity positions to put their money is in customer retention."

Then again, agents can choose to support bonus or buy-back plans that aren't tied to the future sale of their underlying service providers. In fact, companies such as Atlanta-based Network One and Connect America, to name two, will act as ready, able and willing buyers of an agent's commission stream. Based on how much commission the agent receives, how much margin his base affords and attrition levels, these companies will come up with a value based on what they believe the agent's commission stream is worth over the next three to five years, and write the agent a check.

Essentially, there is no cookie-cutter equity offering; agents can choose from a wide array of off-the-shelf programs as well as a few customized ones to meet their needs and wants.

This for That

At present, equity programs offer anywhere from 5 percent to 8 percent commission on an 8.9- or 9.9- cent switched rate. That's a low commission and an average rate in today's market, so participation in an equity program requires the agent to make a trade-off.

Some industry veterans don't see equity programs getting much more competitive because they already are down to skin and bones. "The idea, at least with our program, is to draw agents who aren't consumed with the thought of earning 40 points on a 5-cent rate," remarks Mike Atkinson, vice president of agency sales for Louisville, Ky.-based New Concept Communications (NCC). "Over the last four or five years, I've heard from a number of agents who were getting a very high commission. I've always asked, 'If things are so good, why are you calling me?' The bottom line was that a small percentage of their orders were making it on line, or they hadn't been paid in six months.

"Our agents are selling a fair rate of 8.9 [cents] or 9.9 [cents], and building something for down the road that will help grow the company and not grind it down to the dirt. A company isn't worth anything if it can't continue to operate as a growing concern, with reasonable profits and with reasonable margins," Atkinson adds.

CMS's Foster concurs: "As agents, we have to look at the fact that there are far too many Tier IV resellers that have over committed themselves to their underlying carriers, and by lowering rates they're basically pulling money out of their own pocket," he says. "I know what it takes to transport a call on the wholesale end, and when you add the numbers up, they're not profitable. The idea here is to build a company that's an attractive acquisition candidate."

Other agents, such as Silicato and his partner Mark Soloman, refuse to enter a program that requires a trade-off of equity for lower commissions and higher rates. "It's too competitive out there," says Silicato. "We have to have something similar to what we have now, or it doesn't work for us. My sense is that the service providers offering these programs will be forced to lower their rates because the major carriers are lowering theirs. We'll continue to evaluate these equity programs as they evolve and see what develops."

What About Smaller Agents?

For the most part, small agents have been left out of the game for two reasons: Service providers have been targeting the large producers, and agents billing less than $100,000 a month can't afford to cut their commissions in half to participate in an equity share program.

But the worm is beginning to turn. "Let's face it, the guys doing $500,000 a month represent maybe 5 percent of the agents out there," says Gary Packman, director of agent acquisition for Prestige Telecommunications Group Inc., a master agent for CommSource International (CSI), Englewood, Colo. "Eighty percent of the agents on the street today are in the $100,000 or below range. That's why we've opened our plan to agents with as little as $25,000 in monthly billings."

It's only a matter of time before agents across the board are getting a piece of the action, according to Mark Belfeld, director of agency and wholesale services for Evansville, Ind.-based OneStar. "A lot of service providers are having trouble recruiting new direct salespeople," he says. "They're going to have to get creative. We started an equity agent program about three months ago because we were having trouble growing our direct sales team. The program already accounts for 25 percent of new sales."

Master agencies US Telebrokers, Intelisys and Prestige, to name three, are teaming with their underlying service providers to offer equity share programs for sub-agents, which could set the stage for an explosion of programs aimed at smaller agents.

Strength in Numbers

William H. Power and Gregory J. Praske, president and CEO, respectively, of McLean, Va.-based Association Resource Group Inc., have assembled a consortium of high-powered agents who are working together to cash in on their large customer bases.

When the group met earlier this year, it included 12 agents with combined monthly billings of approximately $7 million. Essentially, these agents formed what is known as a "20 Group" in the automotive industry, wherein 20 or so executives from non-competing dealerships gather regularly to exchange information and ideas.

"The sharing of information and experiences is often neglected in the chase for dollars," says Praske. "It's extremely helpful for agents to know details of the deals struck by other agents."

Even if the members never actually "tie together" their revenue to swing a big equity deal with one or more carriers, Praske says the experience is worthwhile for the camaraderie and strategy gained. Praske says the 20 Group will assemble again to discuss strategy at the Agent Educational Network (AgENt) Trade Fair, a conference produced by the publishers of PHONE+ magazine in Tampa, Fla., Oct. 20-21.

Already, rumors are flying about master agents leveraging their reputations and relationships with major carriers to set up the future acquisition of a specific reseller they plan to build over the next two to three years. Then, too, several heavy hitters that bill well over seven figures a month are talking to each other on the phone, exchanging e-mails and meeting face-to-face to recruit each other to particular programs. Theoretically, these agents could round up 10 to 15 colleagues and drop $8 million to $10 million of new monthly business on a long distance company's doorstep in less than 12 months. Now that would attract a buyer.

Historically, the agent-service provider relationship has been strained, full of mistrust and fraught with misunderstandings. But what we're beginning to see is a new level of cooperation among some agents and underlying service providers. And it's getting contagious.

Bob Titsch Jr. is editorial director of the Telecom Division at Virgo Publishing Inc., which includes PHONE+ Magazine. Peter Meade is executive editor of PHONE+.

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